Dorsey Wright: Your Turnkey Portfolio Construction Solution

Dorsey, Wright & Associates (DWA), a Nasdaq Company, has been at the forefront of technical analysis and relative strength investing for decades. In this article, IRIS interviews Tom Dorsey, founder, DWA, to discuss the firm’s evolution and the development of their fintech platform:

IRIS: Can you provide an overview of the DWA relative strength concept?

Tom Dorsey: Point and Figure charting was created by Charles Dow, who was founder and editor of The Wall Street Journal. It was and is a logical, organized way of recording the imbalance between supply and demand. In the end, if there are more buyers than sellers, price must rise. If there are more sellers than buyers, price must decline. If buying and selling are equal, price must remain the same – there is nothing else. The Point and Figure charting method was developed using Xs and Os where X represents rising prices, and O’s represent declining prices, to plot the relationship between supply and demand within a given security in a logical, organized fashion. Because the chart uses price as its only input, the Point and Figure methodology is one of the simplest approaches to stock analysis, and it’s easy to understand and explain.

Point and Figure relative strength is a natural extension of this. Relative strength is something that we [DWA] have used for almost 30 years. It is a methodology of simply dividing one thing by another; for example, if I wanted to compare the price of Pepsi Cola to Coca Cola, I would divide the price of Pepsi by the price of Coke, and once that division is done, a number is generated, and you can plot it on a Point and Figure chart. This division is performed each day, and though there is not a change to the chart each day, over time, basic patterns develop and allow us to determine which security is exhibiting the best relative strength.

Thirty years ago, we could only create about 200 relative strength charts in a week, as it was time-consuming to create the relative strength charts by hand. We knew they were important but we just didn’t have the technology available to be able to run a large volume of these charts.

As technology began to advance and computers became faster, we were able to do more of them and, as a result, utilize more relative strength within our research. So as tech got better and better, we began to ratchet up the number of relative strength charts we did — first doing it on US equities, then starting to go around the world. Today, we calculate approximately 7.5 million relative strength charts every night. We compare everything to everything: we compare Indonesia to Spain, Spain to Malaysia, Malaysia to Hong Kong, Hong Kong to N. Korea or S. Korea, China. We compare everything, and the computer lays it out for us, exactly where the strength is and where the weakness is, because just like the Point and Figure chart, a buy signal is simply a column of Xs that exceeds the previous column of Xs, and a sell signal is simply a column of Os that exceeds a previous column of Os.

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IRIS: So it’s universal across asset classes?

Tom Dorsey: Absolutely. If it has a price, you can compare and contrast it. I use the analogy of two people in an arm-wrestling match. I might have 20 stocks that I know are the 20 best “arm wrestlers” in the country, but I can only take 10 to Las Vegas with me. I’ll have these guys arm wrestle each other until I know which 10 are the strongest out of the 20, and then I’ll take those winners with me. We can compare stocks to stocks, stocks to ETFs, ETFs to commodities, etc. and that helps us cull down the original inventory to the securities exhibiting the best relative strength.

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IRIS: How similar is relative strength to a momentum strategy?

Tom Dorsey: The two are different, although they are often stacked under the same name. Momentum typically has a time frame. You may look at 20-day momentum or a two-month momentum; whatever the duration, it’s going to have a timeframe that you’re looking at.

Relative strength does not. Relative strength charts go on indefinitely. Take for instance the stock Danaher. Danaher has had positive relative strength relative to the S&P 500 since 1995. In other words since 1995, if you had to choose between Danaher or the S&P 500—and that’s all you could have in your portfolio—relative strength says you should have owned Danaher since 1995.

IRIS: How do you define Smart Beta and what makes DWA’s approach to Smart Beta different than others?

Tom Dorsey: To me, smart beta is a rules-based process that can be clearly defined, that the buyer of the product can understand completely, and helps to manage money in a logical and organized way.

A while back, I coined the term “ETF Alchemy.” In chemistry, H2 + O = water. Those are two different elements put together to create something new. We do the same thing with our strategies. We find things that combine and match up in an effort to make a better product.

For example, we provide the underlying index for the PowerShares DWA Tactical Multi-Asset Income Portfolio (DWIN), a multi-asset income product. The Index considers an inventory of funds from across seven different income-producing segments of the market (Treasuries, International Fixed Income, Domestic Fixed Income, Equity Income, Preferreds, Real Estate, and MLPs), and ranks the inventory from strongest to weakest based on relative strength. We then select the top five highest yielding ETFs out of the top half of those rankings and reevaluate this Index on a monthly basis. We know that within the Fixed Income asset class, there is rotation, and different segments will outperform at different times. Our goal is to select the strongest funds from within the inventory, and rotate funds in and out of the index, as our relative strength methodology dictates.

That’s what Dorsey Wright is all about: not only creating these products, but finding an alchemic way to combine them.

IRIS: You mentioned alchemy. There is a notion among certain investors that you cannot beat the market and that passive investing will win over time. What would you say to an RIA, advisor, or individual investor who thinks along those lines?

Tom Dorsey: I would say that I agree, I think certain aspects of an investment process should be passive. However, let me clarify what I mean by passive investing. When you look at a particular model, such as our DWA Yield Model, that is going to own the five stocks in our Model. We select the stocks with the best relative strengths and the highest yields. Once I choose to put that brick in the wall, that goes into my portfolio, and I am going to be very passive with that. I know that if there is a change in that portfolio, Dorsey Wright will e-mail me and let me know that I need to sell a particular item there, and replace it with another item.

This can be understood in terms of baseball. You put your best pitcher on the mound at the start of the game. By the fifth inning, he starts to walk some of the opposing team, he has three home runs hit on him, the opposing team is beginning to steal bases on him. The coach, disconcerted, goes to the mound and asks the pitcher what’s wrong. The pitcher says that his arm is sore. The coach sends him to the bullpen where the other pitchers are beginning to warm up and replaces him with the pitcher with the best relative strength.

That’s what happens in a portfolio. So while I agree that passive investing is the right way to go, you need something extra in that game. The passive investor’s thinking in the game is: “I own the team, but I’m going to sit up in the stands and watch the game. I have no intervention in the game. I’ve got the best coaches and players, and the coach will handle the team.” So that is the passive side of the coin; there can still be some active decisions taking place.

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IRIS: Tell us how DWA got into the Fintech space.

Tom Dorsey: Technology truly revolutionized the way we do business today and has made it possible for us to bring our relative strength analysis to the masses. Nearly 30 years ago, our team charted the optionable stock universe of approximately 200 stocks by hand. As technology improved, so did our ability to compare and contrast relative strength readings on a broader level. We went from charting 200 hand-written charts a week to our current model of charting more than 7.5 million charts a day.

Our Global Technical Research Platform [a web-based solution for portfolio construction, ETF comparisons and analytical research] provides clients with access to technical research tools that they can use to evaluate global securities and the markets. The research provides our clients – thousands of advisors and broker-dealers — with a radar on areas of the market that are showing strength, and therefore warrant a closer look, as well as areas they should avoid. The platform is an easy-to-use website that provides daily market reports and analysis, and a variety of tools that help with asset allocation and portfolio construction. We chart over 150,000 securities and market indicators on a daily basis.

In 2002, we started providing strategic ETF models, starting with basic sector rotation models. Now we have about 30 different guided ETF models that provide solutions beyond US sector rotation. We provide additional tools that show which asset classes are in/out of favor. We are seeing adoption among traditional financial advisors and broker-dealers who are looking for a way to streamline their processes. They rely on the platform and relative strength signals to provide them with unemotional, objective guidance. We are also beginning to see the next generation of investors who utilize robo advisors. Our tools allow our advisor clients to provide a fee-based service to their younger clientele that mirrors the objectivity they are seeing on the automated asset allocation systems. Technology is amazing and we need to embrace it – it’s not slowing down. It allows us, by way of our platform, to provide more tools to advisors and make their portfolio management process more efficient.

Dorsey, Wright & Associates, LLC, a Nasdaq Company, is a registered investment advisory firm.The information contained herein has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this material without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. The relative strength strategy is not a guarantee. There may be times where all investments or asset classes are unfavorable and depreciate in value. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.